Fiddling While Rome Burns

A new study from Harvard Professors Bebchuk, Cohen and Spamann, The Wages of Failure tells us that regardless of running a company into the ground, executives make sure they get theirs.

The study focuses on Bear Stearns and Lehman Brothers.

We find that the top-five executive teams of these firms cashed out large amounts of performance-based compensation during the 2000-2008 period. During this period, they were able to cash out large amounts of bonus compensation that was not clawed back when the firms collapsed, as well as to pocket large amounts from selling shares.

Overall, we estimate that the top executive teams of Bear Stearns and Lehman Brothers derived cash flows of about $1.4 billion and $1 billion respectively from cash bonuses and equity sales during 2000-2008. These cash flows substantially exceeded the value of the executives’ initial holdings in the beginning of the period, and the executives’ net payoffs for the period were thus decidedly positive. The divergence between how the top executives and their shareholders fared implies that it is not possible to rule out, as standard narratives suggest, that the executives’ pay arrangements provided them with excessive risk-taking incentives.

Boy, if Harvard is acknowledging executive pay is a big problem, you know it is.

The analysis indicates that the design of the firms’ performance-based compensation did not produce a tight alignment of executives’ interests with long-term shareholder value. Rather, the design provided executives with substantial opportunities (of which they made considerable use) to take large amounts of compensation based on short-term gains off the table and retain it even after the drastic reversal of the two companies’ fortunes. Such a design provides executives with incentives to seek improvements in short-term results even at the cost of maintaining an excessively elevated risk of an implosion at some point down the road.

Meaningful limits on stock option unloading, either until retirement or a 10% cap per year.

Anyone connected to the dot con era has also seen this story. Executives with golden parachutes which survive bankruptcy, people dumping their options as soon as possible but before the general stockholder gets wind that the company makes vaporware.

Bottom line is executive compensation as well as corporate governance needs a major overhaul in the U.S.